Connacher’s Woes: Over-Levered and at the Mercy of Global Economic Forces

Shifts in both commodities and credit markets are causing pain for Connacher Oil and Gas, and have led to a “going concern warning“[i] being included in their Q3 results. Connacher is seen as likely to run into difficulties making interest payments, and as a result its stock price is down some 85% from its 2 year highs in April, when WTI crude prices were trading closer to $95. The Alberta based company operates two projects which comprise a combined total of 41 steam assisted gravity drainage (SAGD) well pairs and 13 infill wells, from “a 100% interest in approximately 450 million barrels of proved and probable bitumen reserves,” according to their Q3 filing.

Located on the Great Divide oil sands, Connacher has, over the years, taken on significant levels of debt to finance the construction of its current wells. That debt load currently includes $139 million in first lien loans and $923 million in 8.75% second lien notes, as well as $22 million of a $30 million revolving credit facility.

Current production has been increasing, and according to the earnings call is over 15,000 barrels per day, up more than 25% from the 11,788 that the company was extracting a year ago, yet still under the 20,000 barrels per day that the properties were designed to produce. Also pertinent to the equation — as a commodity producer the company is highly vulnerable to fluctuations in global supply and demand.

The CEO, Chris Bloomer, noted during the Q3 conference call that “…the downturn in the markets has impacted price, and obviously our revenue. The extended duration of this downturn is unknown and as such we need to take a defensive stance with respect to our business. This has led to the going concern note, which is a reflection of this uncertainty, looking forward for the company’s ability to meet its obligations as they come due, given the highly levered position of our balance sheet.” Moody’s analyst Paresh Chari has estimated that if WTI prices were to stabilize at $75, given the $90 million in interest payments that are coming due in 2015, the company would be short changed, as it would have approximately only $70 million in ebitda.

Connacher Price Chart – Click to View a Larger Version

This has led to the company stating on December 1st that it had “initiated a process to devise and implement a strategy to address Connacher’s liquidity and capital structure.” Bloomer had noted during the Q3 conference call that “I think the way we look at it is that current market side of things makes it very challenging to develop a material capital plan beyond what we have, what we’re standing on today. So depending on what the crude price is we’ll have to evaluate that, and our capital structure is already highly levered. And we need to work out a solution that will provide us additional capital going forward.”

There are significant macroeconomic forces at play here, which include most prominently OPEC’s recent attempts to push down oil prices in order to curb competition and growth from other providers, including the American and Canadian shale and oil sands producers. Connacher is certainly among those who have benefited from higher oil prices, and it claimed a profit of $31.29 per barrel on prices of $97.17 in the Q3 filing. Current prices of WTI crude at $65.84 puts the production at dramatically less profitabe levels. This is unlikely to go on indefinitely though, as many of the OPEC states, including its largest producers, require brent crude oil prices (which generally run a few dollars higher than the lighter WTI) in the $99+ area in order to maintain their economies and spending levels. RBC Capital Markets analyst Helima Croft recently noted in early November that

Due to a surge in post Arab Spring spending, we believe that the Saudi government actually needs oil prices north of $100 a barrel in order to balance its budget, and if Brent prices remain in the $80s, it will be forced to run a deficit … A significant portion of the new social spending has also been aimed at keeping Saudi’s large youth cohort occupied and away from extremist groups … In the wake of the 2003 terrorist attacks in Riyadh carried out by nationals, King Abdullah identified youth unemployment as the country’s number one national security challenge … We maintain that the King would not sacrifice domestic and regional stability in order to punish Iran and Russia or bankrupt US shale producers.

How this will affect Connacher and the market at large remains to be seen, although clearly there may be a play here for crude oil bulls. In the meantime, the pain continues.

[i] A SEC-required disclosure for publicly traded companies stating that it is at risk of not being able to continue as a “going concern,” i.e., the company potentially does not have adequate prospects to continue to function in the foreseeable future.